The IRS released final regulations in 2008 under Sec. 7216, modifying previous regulations that had been substantially unchanged for 30 years. The final regulations provide guidance for tax return preparers (preparers) about the disclosure or use of tax return information. 1 Regs. Sec. 301.7216 and recently released Rev. Proc. 2008-35 provide authoritative guidance on the disclosure or use of tax return information. This newly adopted guidance became effective on January 1, 2009.
Sec. 7216 prohibits preparers from “knowingly or recklessly” disclosing or using tax return information. A violation of this section could result in a preparer’s being charged with a criminal misdemeanor, involving a maximum penalty of $1,000 or one year in prison, or both, plus costs of prosecution. Sec. 6713, a companion provision, calls for a civil penalty for improper disclosures or use of tax return information. Under the civil penalty provisions of Sec. 6713, the unauthorized disclosure or use of tax return information could result in an assessment of $250 for each unauthorized action by the preparer, subject to a limit of $10,000 per calendar year. 2
Regs. Sec. 301.7216 generally requires preparers to obtain permission (in written or electronic form) from the taxpayer prior to the disclosure or use of tax return information. Some of the more significant parts of the new regulations involve the form and content of the consents that preparers must generally obtain from taxpayers before disclosure or use of tax return information under the 1040 series of federal income tax returns. This series includes Forms 1040 and 1040A, U.S. Individual Income Tax Return, 1040EZ, Income Tax Return for Single and Joint Filers with No Dependents, and 1040NR, U.S. Nonresident Alien Income Tax Return. Although prior taxpayer consent is required for the disclosure or use of tax return information found on federal business entity forms, such as Forms 1120, U.S. Corporation Income Tax Return, 1065, U.S. Return of Partnership Income, and other federal income tax forms, the form and content of the consent for these forms are more flexible than the consents under the 1040 series of federal income tax returns.
Sec. 7216(b) and the regulations thereunder provide for certain exceptions to penalty assessment. For example, Sec. 7216(b)(1)(B) provides that the penalty shall not apply to the disclosure of tax return information made under a court order. Further, Sec. 7216(b)(2) states that the penalty should not be assessed for the use of information in the preparation of, or in connection with the preparation of, state and local tax returns and estimated tax declarations of the person to whom the information relates. Similarly, if a preparer provides tax return information to the IRS in the course of providing tax return preparation services or in response to a request for information, providing such information to the Service would not constitute a disclosure subject to the penalty. Regs. Sec. 301.7216-2 provides a list of additional permissible disclosures or uses that do not require the preparer to obtain the taxpayer’s consent, some of which are discussed below.
This article also discusses the requirement under Regs. Sec. 301.7216-3 to obtain prior written consent from the taxpayer if an exception does not apply, including an overview of the mandatory form and content of taxpayer consents.
As a prelude to issuing the 2008 final regulations, the IRS released proposed regulations under Sec. 7216 on December 8, 2005. 3 The proposed regulations included expanded or new definitions, including the terms “tax return preparer,” “tax return information,” and “request for consent.” In addition, Notice 2005-93 sets out proposed procedures involving the content and nature of a request for consent. The most significant proposed change was a new requirement that return preparers obtain written consent from the taxpayer before sending any tax return information outside the United States, in response to security and privacy concerns related to the offshore outsourcing of actual return preparation.
Treasury received a significant number of comments on these proposed regulations. Some commentators suggested that the regulations did not go far enough in protecting taxpayers from identity theft. Organizations representing tax practitioners, while sensitive to the need to protect the privacy of taxpayer information, sought less burdensome consent requirements. However, with one significant exception, the final regulations issued in January 2008 for the most part follow the proposed regulations.
Regs. Sec. 301.7216-1 provides the pertinent definitions for Sec. 7216 terminology. Some of these terms are as follows:
Example 1: Bank B is a tax return preparer and an authorized IRS e-file provider. B employs one individual, Q, to solicit the necessary tax return information for the preparation of a tax return; another individual, R, to prepare the return on the basis of the furnished information; a secretary, S, who enters the information on the returns into a computer; and an administrative assistant, T, who uses a computer to e-file the tax returns. All four employees are tax return preparers for purposes of Sec. 7216. However, only R is a tax return preparer under the Sec. 7701(a)(36) definition of tax return preparer. 10
The definition of “tax return information” is very comprehensive under Regs. Sec. 301.7216:
[A]ny information, including, but not limited to, a taxpayer’s name, address, or identifying number, which is furnished in any form or manner for, or in connection with, the preparation of a tax return of the taxpayer. This information includes information that the taxpayer furnishes to a tax return preparer and information furnished to the tax return preparer by a third party. Tax return information also includes information the tax return preparer derives or generates from tax return information in connection with the preparation of a taxpayer’s return. 11
The breadth of the regulations’ definition of tax return information is illustrated by the following. Tax return information includes statistical compilations of such information, even in a form that cannot be associated with or otherwise identify, directly or indirectly, a particular taxpayer. 12 Tax return information does not include information identical to any such information that has been furnished to a tax return preparer if the identical information was obtained for another matter not connected with the preparation of the return. 13 Information maintained in a form that is associated with tax return preparation, however, becomes tax return information regardless of how the tax return preparer initially obtained the information. 14
Example 2: Taxpayer A purchases computer software designed to help prepare and file her income tax return. When A loads the software onto her computer, it prompts her to register her software. As part of the registration process, the software provider states that it will provide registrants with any updates to the software.
In this situation, the software provider is a tax return preparer under Regs. Sec. 301.7216-1(b)(2)(i)(B), and the information that A provides to register her purchase is tax return information because she is providing it in connection with the preparation of a tax return. 15
Example 3: Corporation A is a brokerage firm that maintains a website through which its clients may access their accounts, trade stocks, and generally conduct a variety of financial activities. Through its website, A offers its clients free access to its own tax preparation software. Taxpayer B is A’s client and gave A his name, address, and other information when registering on A’s website to use A’s brokerage services. In addition, A has a record of B’s brokerage account activity, including sales of stock, dividends paid, and IRA contributions made. B uses A’s tax preparation software to prepare his tax return. The software populates some fields on B’s return based on information A already maintains in its databases.
A is a tax return preparer within the meaning of Sec. 301.7216-1(b)(2)(i)(B) because it has prepared and provided software for use in preparing tax returns. The information in A’s databases that the software accesses to populate B’s return (i.e., the registration information and brokerage account activity) is not tax return information because A did not receive that information in connection with the preparation of a tax return. Once A uses the information to populate the return, however, the information associated with the return becomes tax return information. If A retains the information in a form in which A can identify that the information was used in connection with the preparation of a return, the information in that form is tax return information. If, however, A retains the information in a database in which A cannot identify whether the information was used in connection with the preparation of a return, that information is not tax return information. 16
Use of tax return information includes any circumstance in which a preparer refers to, or relies on, tax return information as the basis of an action. 17
Example 4: Preparer G determines, upon preparing a return, that a refund is due to the taxpayer. G will ask whether the taxpayer would like a refund anticipation loan. G does not ask the question if the taxpayer is not due a refund. G is using tax return information when it asks whether a taxpayer is interested in obtaining a refund anticipation loan because G is basing the inquiry on the taxpayer being entitled to a refund. 18
A disclosure is the act of making tax return information known to any person in any manner whatever. Hyperlink transfers are disclosures. 19 A hyperlink is the device used to transfer an individual’s tax return information, using tax preparation software from a tax return preparer’s webpage, to a webpage operated by another person without the individual having to separately enter the web address on the destination page. 20 An example of a hyperlink disclosure is when the taxpayer uses the preparer’s web address to transmit tax return information. The transmission of tax return information is a disclosure by the preparer subject to penalty under Sec. 7216 if not authorized by regulation. 21
Preparers should be aware of the importance of documentation, which is critical for consent to use or disclose a taxpayer’s tax return information. “Request for consent” includes any effort by a preparer to obtain the taxpayer’s consent. When the preparer requests a taxpayer’s consent, any associated efforts of the preparer, including, but not limited to, verbal or written explanations of the form, are part of the request for consent. The definition of request for consent includes the act of supplying a taxpayer with a paper or electronic form that meets the requirements of a revenue procedure published under Regs. Sec. 301.7216-3(a). 22 The preparer should document his or her actions and procedures to request taxpayer consent. 23
In defining permissible disclosures and uses, Regs. Sec. 301.7216-2 contains several significant changes from the prior regulations. In particular, the regulations add new rules to the process by which preparers disclose taxpayer information to any other firm and, in particular, any firm or contractor located outside the United States.
Preparers within the same firm in the United States may use or disclose information within the firm to assist in the preparation of, or provide auxiliary services in connection with, return preparation. However, any disclosure or use of tax return information outside the United States requires specific consents as defined under Regs. Sec. 301.7216-3.
A preparer may make disclosure to another preparer located within the United States, as long as the services provided are not substantive determinations or advice affecting the tax liability reported by the taxpayer. In response to a commentator’s request for clarity, the regulations define a substantive determination as one that “involves an analysis, interpretation, or application of the law.” 24 Nonsubstantive determinations will generally be those associated with ministerial-type actions required to complete and process the tax return.
In general, under the regulations’ attorney- accountant rule, a preparer who is lawfully engaged in the practice of law or accountancy and prepares a tax return may use the taxpayer’s information or disclose it to another member of the firm in order to provide other legal or accounting services to the taxpayer. 25 However, practitioners should note two significant differences from the prior regulations. The revised attorney-accountant provision permits only disclosures and uses within the United States. Moreover, a related or affiliated firm is not considered to be part of the definition of a “law or accounting firm,” thereby requiring taxpayer consent for any disclosures a preparer makes to a related or affiliated firm. 26
A preparer inside the United States may not make any disclosure to a party outside the United States (including a related or member firm) without the taxpayer’s consent as set out in Regs. Sec. 301.7216-3. However, if a taxpayer initially furnishes tax return information to a preparer located outside the United States, that information may be disclosed to or used (without a specific consent) by other members of that firm to assist with the preparation of the taxpayer’s return. 27
A preparer may disclose tax return information to a person under contract with the preparer in connection with the programming, maintenance, repair, testing, or procurement of equipment or software used in return preparation only to the extent necessary for the person to provide the contracted service, and only if the preparer ensures that everyone who receives disclosures of tax return information also receives a written notice informing them of the applicability of Secs. 6713 and 7216 and the rules and penalties that apply under those sections. 28
The preparer may compile and maintain a list of his or her clients’ names, addresses, e-mail addresses, and phone numbers for the sole purpose of offering tax information or additional tax return preparation services to those taxpayers. 29 Similarly, the preparer may produce certain statistical compilations as long as such information relates directly to the preparer’s return preparation business. 30
Regs. Sec. 301.7216-2 also identifies a variety of other permissible disclosures and uses that a preparer may make without specific taxpayer consent. These authorizations are narrowly drawn and among other things permit disclosures and uses of taxpayer information. Specific taxpayer consent is not necessary if:
Taxpayer consent is not needed if the disclosure or use of the return information is under a court order or an administrative order, demand, request, summons, or subpoena issued in the performance of its duties by a federal or state agency, the U.S. Congress, a professional association ethics committee or board, or the Public Company Accounting Oversight Board. 32 Further, the preparer does not have to obtain the taxpayer’s written consent when updating the taxpayer’s software to address changes in IRS forms and e-file specifications. 33
The 2008 final regulations retain the 30- year-old rule recognizing that taxpayers should have control over their own tax return information and, with appropriate safeguards, should be able to direct preparers to disclose and use tax return information as they see fit.
Regs. Sec. 301.7216-3(a)(1) provides that, unless Sec. 7216 or Regs. Sec. 301.7216-2 specifically authorizes the disclosure or use of tax return information, a preparer may not disclose or use a taxpayer’s tax return information prior to obtaining written consent from the taxpayer. Thus, a preparer may disclose or use tax return information as the taxpayer directs as long as the preparer obtains prior written consent from the taxpayer.
Regs. Sec. 301.7216-3(b)(4), as issued in January 2008, originally provided that a preparer located within the United States (including any U.S. territory or possession) (the U.S. preparer) could not obtain consent to disclose the taxpayer’s Social Security number (SSN) to a preparer located outside the United States (the foreign preparer). This would have resulted in a U.S. preparer having to redact or otherwise mask the taxpayer’s SSN before the U.S. preparer could disclose the other tax return information outside the United States. Treasury and the IRS incorporated this restriction in the January 2008 regulations because of concern about identity theft when an individual’s confidential information is disclosed outside the United States. 34
The provision resulted in the unintended consequence of restricting taxpayers’ ability to direct their tax return preparers to disclose tax return information as they saw fit and made it extremely difficult for CPA firms to provide services to international clients in an efficient manner. For example, many expatriates have tax filing obligations in multiple countries. CPA firms are often engaged to prepare expatriates’ tax returns for filing in many countries. The firms cannot do this without sharing information with affiliated foreign firms to complete the applicable tax returns.
In response to concerns raised by the AICPA’s Section 7216 Task Force and many other preparers, on July 1, 2008, Treasury and the IRS issued final and temporary regulations and Rev. Proc. 2008-35. 35 The new pronouncements focused on updated guidance on the disclosure of a taxpayer’s SSN to foreign preparers. Generally, a U.S. preparer may not obtain taxpayer consent to disclose a taxpayer’s SSN for taxpayers filing a return in the Form 1040 series to a foreign preparer. As was the case in the January 2008 regulations, if a U.S. preparer receives taxpayer consent to disclose tax return information to a foreign preparer, the U.S. preparer must redact or otherwise mask the taxpayer’s SSN before the tax return information is disclosed outside the United States. 36
If a U.S. preparer initially receives or obtains a taxpayer’s SSN from a foreign preparer, the U.S. preparer may retransmit without consent the taxpayer’s SSN to the foreign preparer that initially provided the SSN to the U.S. preparer. 37
As an exception to the general rule, U.S. preparers may disclose an SSN to foreign preparers if:
If a U.S. preparer wants to disclose a taxpayer’s SSN outside the United States and either the U.S. or the foreign preparer, or both, do not have adequate data protection safeguards, the general rule above will apply. Therefore, the U.S. preparer will be required to redact or mask any SSN prior to the disclosure of tax return information to a foreign preparer, even if the taxpayer has consented to the SSN disclosure. 39
The regulations also clarify that a foreign preparer does not include a preparer who is continuously and regularly employed in the United States and who travels temporarily outside the United States on business. 40
Rev. Proc. 2008-35 provides guidance on the requirements for an adequate data protection safeguard. U.S. preparers seeking to disclose a taxpayer’s SSN to foreign preparers should familiarize themselves with these safeguards. An important requirement is that both the U.S. and foreign preparers maintain an adequate data protection safeguard at the time the taxpayer’s consent is obtained and when making the disclosure. 41 U.S. preparers seeking to disclose a taxpayer’s SSN to foreign preparers will therefore have to understand the operation of the information retention and processing systems of both the U.S. and the foreign preparers, including ongoing monitoring of compliance with the mandated safeguards to ensure that both preparers comply with the final regulations’ requirements.
An adequate data protection safeguard is a security program, policy, or practice that firm management has approved and implemented. It includes administrative, technical, and physical safeguards to protect tax return information from misuse or unauthorized access or disclosure and must meet or conform to one of the following privacy or data security frameworks:
Regs. Sec. 301.7216-3(a)(1) requires that a taxpayer’s consent be knowing and voluntary. Generally, conditioning the provision of any services on the taxpayer’s furnishing consent will make the consent involuntary and thus not satisfy the requirements of the regulations. 43
As an exception to this general rule, a preparer may condition its provision of preparation services upon a taxpayer’s consent to disclose the taxpayer’s tax return information for performing services that assist in the preparation of, or provide auxiliary services in connection with, the preparation of the taxpayer’s tax return. 44
As an example, making the use of a tax return preparation software contingent on the taxpayer’s consenting to the preparer’s use of the taxpayer’s tax return information for use in displaying targeted banner advertisements does not satisfy the final regulations’ requirements and is therefore invalid. In this example, the use of the taxpayer information for targeted banner advertisements is not considered part of the tax return preparation. 45
The 2008 final regulations do not provide much clarifying guidance on “auxiliary services in connection with the preparation of the tax return of the taxpayer.” 46 For example, an expatriate’s employer may engage a CPA firm to prepare the expatriate’s U.S. and foreign tax returns and to calculate tax equalization payments under the employer’s expatriate program. It is not clear under the 2008 final regulations whether the calculation of the equalization payments is considered “auxiliary services in connection with the preparation of the tax return of the taxpayer.” Thus, it is not clear whether a preparer may condition the provision of any services related to calculating the equalization payments on the taxpayer’s furnishing consent.
Treasury and the IRS were concerned that repeated requests might cause undue pressure on taxpayers to consent. Consequently, where a taxpayer has declined a request for consent to the disclosure or use of tax return information for purposes of solicitation of business unrelated to tax return preparation, the preparer may not solicit another consent from the taxpayer for a purpose substantially similar to that of the rejected request. 47
According to the preamble to the 2008 final regulations, under this rule there is no prohibition on the taxpayer’s independently asking the preparer about a disclosure or use of the taxpayer’s same tax return information after a declined consent request.
A preparer must obtain written consent from a taxpayer before the preparer discloses or uses the taxpayer’s tax return information. Retroactive consents will therefore not be valid. 48
In the case of consent for the disclosure and use of tax return information for the solicitation of business unrelated to tax return preparation, the preparer may not request a taxpayer’s consent after the preparer has provided a completed tax return to the taxpayer for signature. 49 From a practical perspective, the ideal time to request consent from the taxpayer is when the tax practitioner executes an engagement letter with the taxpayer.
Unless a consent document specifies the duration of the taxpayer’s consent to the disclosure and use of tax return information, the consent will be effective for a period of one year from the date the taxpayer signs the consent. 50
Practitioners should assess the facts and circumstances to determine the appropriate duration for which they are seeking taxpayer consent.
Given Treasury and the IRS’s concern about the potential for confusion surrounding the distinction between “disclosure” and “use,” particularly among individuals, the 2008 final regulations prescribe rules on multiple disclosures or multiple uses. 51 The applicable rules depend on the type of taxpayer as set out below.
A taxpayer cannot authorize uses and disclosures by a single written consent. Separate written documents are required for uses and for disclosures. The separate written document for uses may contain consent to multiple uses, and the separate written document for disclosures may contain consent to multiple disclosures. Where a written document authorizes multiple uses or disclosures, it must specifically identify each use or disclosure, respectively. 52
There is an exception for taxpayers not filing returns in the Form 1040 series. Those taxpayers may authorize both uses and disclosures in a single written consent. 53
Regs. Sec. 301.7216-3(a)(3) has been modified to provide:
Rev. Proc. 2008-35 provides guidance to preparers on the format and content of consents to disclose and consents to use tax return information for taxpayers filing a return in the Form 1040 series.
Under Regs. Sec. 301.7216-3(a)(3)(iii), for preparers providing tax return preparation services to taxpayers that do not file an income tax return in the Form 1040 series, a consent to use or a consent to disclose may be in any format, including an engagement letter to a client, as long as the consent complies with the requirements of Regs. Sec. 301.7216-3(a)(3)(i).
The exhibit provides a summary of the various requirements applicable to the format and content of consents for different taxpayers. 54
Nayan Bhikha is with PricewaterhouseCoopers LLP in Washington, DC. Paul Eldridge is with Pricewaterhouse- Coopers LLP in New York, NY. Michael Dolan is with KPMG LLP in Washington, DC. Danny Snow is with Thompson Dunavant PLC in Memphis, TN. Ruth Ann Michnay is with Ruth Ann Michnay, P.A., in Oakdale, MN. John Miller is a faculty instructor at Metropolitan Community College in Omaha, NE. For more information about this article, please contact Michael Dolan at mpdolan@kpmg.com.
Notes
1 T.D. 9375. This article will refer to the regulations promulgated in this Treasury Decision collectively as Regs. Sec. 301.7216.
2 Unlike Sec. 7216, Sec. 6713 does not contain a “knowingly or recklessly” standard. In all other respects, the application of Sec. 6713 mirrors the provisions of Sec. 7216.
4 Regs. Sec. 301.7216-1(b)(1). The types of tax returns subject to the Sec. 7216 provisions
are federal income tax returns and are much narrower than the types of returns subject to the regulations under Sec. 6694.
5 Regs. Sec. 301.7216-1(b)(2). The definition of “tax return preparer” is much broader than the definition of a tax return preparer for purposes of Sec. 6694.
6 Regs. Sec. 301.7216-1(b)(2)(ii).
7 Regs. Sec. 301.7216-1(b)(2)(iii). An example under Regs. Sec. 301.7216-2(d) includes one preparer disclosing tax return information to another preparer in order to have the second preparer transfer that information to, and compute the tax liability on, a taxpayer’s tax return by means of electronic, mechanical, or other form of tax return processing service.
8 Regs. Sec. 301.7216-1(b)(2)(iv).
9 Regs. Sec. 301.7216-1(b)(2)(v).
10 Regs. Sec. 301.7216-1(b)(2)(vi), Example (1).
11 Regs. Sec. 301.7216-1(b)(3)(i).
12 Regs. Sec. 301.7216-1(b)(3)(i)(B). The IRS has provided interim guidance on this provision in Notice 2009-13, 2009-6 I.R.B. 447.
13 Regs. Sec. 301.7216-1(b)(3)(i)(C).
14 Regs. Sec. 301.7216-1(b)(3)(ii), Example (2).
15 Regs. Sec. 301.7216-1(b)(3)(ii), Example (1).
16 Regs. Sec. 301.7216-1(b)(3)(ii), Example (2).
17 Regs. Sec. 301.7216-1(b)(4)(i).
18 Regs. Secs. 301.7216-1(b)(4)(i) and (ii).
19 Regs. Sec. 301.7216-1(b)(5).
20 Regs. Sec. 301.7216-1(b)(6).
21 Regs. Sec. 301.7216-1(b)(5).
22 Regs. Sec. 301.7216-1(b)(7).
23 Regs. Sec. 301.7216-1(c) states that Sec. 7216 and the regulations thereunder are not superseded by, nor do they supersede, the requirements under the Gramm- Leach-Bliley Act, P.L. 106-102.
24 Regs. Sec. 301.7216-2(d)(1).
25 Regs. Sec. 301.7216-2(h).
26 Regs. Sec. 301.7216-2(h)(1)(ii).
27 Regs. Sec. 301.7216-2(c)(3).
28 Regs. Sec. 301.7216-2(d)(2).
29 Regs. Sec. 301.7216-2(n).
30 Regs. Sec. 301.7216-2(o).
31 Regs. Sec. 301.7216-2(e).
32 Regs. Sec. 301.7216-2(f).
33 Regs. Sec. 301.7216-2(c)(1).
34 See the preamble to T.D. 9375.
35 See T.D. 9409, T.D. 9437, and Rev. Proc. 2008-35, 2008-29 I.R.B. 132. This modification, which was made final as part of T.D. 9437 on December 16, 2008, allows disclosure of a taxpayer’s SSN by a U.S. preparer to a foreign preparer with taxpayer consent if certain security procedures are in effect.
36 Regs. Sec. 301.7216-3(b)(4)(i).
38 Regs. Sec. 301.7216-3(b)(4)(ii).
39 See the preamble to T.D. 9437 released on December 16, 2008.
40 Regs. Sec. 301.7216-3(b)(4)(i).
41 Rev. Proc. 2008-35, §4.07.
43 Regs. Sec. 301.7216-3(a)(1).
44 Regs. Sec. 301.7216-3(a)(2).
45 Rev. Proc. 2008-35, §6.01, Example (1).
46 Regs. Sec. 301.7216-1(b)(2)(iii) defines providing auxiliary services thus: “A person is engaged in the business of providing auxiliary services . . if, in the course of the person’s business, the person holds himself out to tax return preparers or to taxpayers as a person who performs auxiliary services . . [or if] the person receives a taxpayer’s tax return information from another tax return preparer pursuant to the provisions of §301.7216-2(d)(2).” The definition itself uses the words “auxiliary services” and therefore does not provide the clarity required. The preamble to the January 2008 regulations states that the definition of auxiliary services includes analysis of data for purposes of monitoring the tax return preparer’s business for fraud
prevention and provision of data storage services (preamble to T.D. 9375, §2.E).
47 Regs. Sec. 301.7216-3(b)(3).
48 Regs. Sec. 301.7216-3(b)(1).
49 Regs. Sec. 301.7216-3(b)(2).
50 Regs. Sec. 301.7216-3(b)(2).
51 See the preamble to the January 2008 regulations (T.D. 9375).
52 Regs. Sec. 301.7216-3(c)(1).
53 Regs. Sec. 301.7216-3(a)(3)(iii).
54 The table was provided courtesy of PricewaterhouseCoopers LLP.